The paper presents a ‘trilemma’ with three actors: financial integration, financial stability and national supervision. Combine freedom of capital movements and exchange rate stability while retaining national monetary policies - or not?
Trilemma of Financial Integration, Financial Stability and National Supervision
On 2 December the ECOFIN Council will review, and possibly adopt, proposals advanced by the European Commission on 23 September 2009. The Commission recommended setting up an advisory European Systemic Risk Board (ESRB) and upgrading the EU bodies of national supervisors that monitor individual banks and insurance companies, as well as securities markets, into a European System of Financial Supervisors (ESFS).
The ESFRC sees these complex, and in some respects bold and controversial, proposals as constructive efforts to lessen the risk of a repeat of the traumatic experience of financial turbulence over the past couple of years. This is a situation in which it is only possible to achieve two out of three desirable features; in this case, financial integration, financial stability and national supervision. Opinions on where priority should lie in resolving this trilemma are not unanimous, and the required broad-based political debate has so far not even started. With the new emphasis on strengthening financial stability following the recent crisis, there is a danger that financial integration could be jeopardized due to the fact that supervision is exercised by national supervisors and not by a European supervisor.
There is an analogy to the process of creating the Euro. In Maastricht, nearly two decades ago, EU member governments also faced a trilemma: could they combine freedom of capital movements and exchange rate stability while retaining national monetary policies? Most of them decided they could not and the treaty was changed to provide a framework in which a joint monetary policy replaced national policies. Today, governments cannot, in the foreseeable future, envisage a treaty change, even if they might agree on what it would take to make it possible to assign responsibility for financial supervision to the EU level. They have to ‘muddle through’ by improving coordination of their respective abilities to identify systemic risks, as well as those facing individual financial institutions. While making the best of this task, the European Shadow Financial Regulatory Committee (ESFRC) strongly encourages the relevant political authorities to pay particular attention to the implications of cross-border activities of the large banks and to urgently consider the creation of a European supervisor for these large, pan-European banks in the future.
© ESFRC - European Shadow Financial Regulatory Committee
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